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Credit Crunch to Leave Iran’s Money Market

Following Money and Credit Council’s (MCC) act, as supervisory authority over the Central Bank of Iran (CBI), on lowering the reserve requirement rate, this rate, which used to stand at 13.5% for most commercial banks and institutions, will drop to 10%.

Respecting measures such as “cooperation with the CBI’s supervisory body”, “commitment to transparency and disclosure procedures”, “the provision of the required information for the CBI’s credit and supervisory bodies”, and “lending money with the cost compliant with the maximum rate allowed by the MCC”, are asserted as incentives for the respective banks to enjoy drops in reserve requirement rates to as much as 10%.

At law, lenders and credit institutions are legally obliged to hold part of their total deposits in reserve with the CBI, which is called the reserve requirement. According to article 14 of the Money and Banking Regulation, the proportion of the reserve requirement rate should not fall below 10% or exceed 30%. Hence, the recent act indicates that this limitation has hit the assigned legal floor.

As an expansionary policy, lowering the minimum fraction of customer deposits as reserves will provide the banking system with more funds on tap. As the CBI officials estimate, each 1% reduction in the reserve requirement rate will add 4% to liquidity. In addition, banks’ released financial statements (for the FY ended 19 March 2015) illustrate that among the existing lenders in the sector, 16 of them are totally in possession of about $11.63 bn of reserves and thus, reducing this rate to about 10% for all of them (a hypothesis only) will increase their lending capacity by $2.70 bn.

If the same happens for the rest of the industry, approximately $5.41 bn will be added to the current capacity, which will record a significant growth in the monetary base (up to 14%), taking the current monetary base ($37.87 bn until September 2015) into account.

Table 1. Estimations of the Freed Funds of the 16 Banks

The question, now, is why the CBI, already aware of this policy’s inherent complexities, intends to implement it and does not step in to reduce the cost of money.

Evidently, such a policy is self-descriptive. In fact, if the expansionary policy were supposed to be conducted through lowering the interest rate, the result would not certainly be contractionary. However, the policy of lowering reserve requirement rate, as an efficient instrument, would be utterly fruitless provided that the resultant funds were allocated to banks that in turn would impact the money multiplier as well.

This could ruin the policy maker’s end goal which is to erase bad debts from balance sheets of the related banks. But the main intention behind this decision is to pull down this sector’s liabilities to the CBI with the least economic expansionary impacts.

Through this mechanism, banks’ debt reduction to the CBI has been prioritized, which itself will decrease the monetary base, leading to a deep drop in the expansionary effect of this policy. Since President Rouhani’ presidency, the CBI has aimed at lowering the inflation rate, even to a single-digit rate, as its main goal while the economic growth had not been addressed at all. In other words, the CBI has more stressed on its role in controlling liquidity and passed the economic growth burden on to the Ministry of Economic Affairs and the Planning and Management Organization.

Since the CBI’s decision to reduce banks’ reserve requirements directly affects their lending capacity, the figures for the granted facilities during the first 7 months of the current year are investigated below.

According to statistics released by CBI, this authority has allocated funds to “Agriculture”, “Mines and Industries”, “Housing and Construction”, “Trade”, “Services” and “Miscellaneous” sectors.

As can be seen in the following table, allocation of loans among economic segments has not been subject to significant modifications during the past 4 years. Housing, Trade, and Agriculture sectors have been allocated 13%, 13% and 9% of total facilities (loans), respectively, experiencing the least of changes. However, the Services sector’s share has increased from 33% in 2012 to 38% in 2015.

On the other hand, the Mines and Industries sector’s portion has decreased from 33% in 2012 to 29% in 2015. Furthermore, based on the CBI’s report, facilities have been more offered to finance working capital in manufacturing units.

Table 2. Facilities Granted to Each Sector (%)

According to the following diagram, the CBI has allowed banks to allocate funds for targets such as “money creation”, “working capital”, “repairment”, “development”, “personal goods purchase”, “house purchase”, and “others”.

Based on the CBI statistics, in the first seven months of the current year, meeting their needs to deal with the working capital has been bankers’ first priority by allocating 62.4% of their funds to this end.

Diagram 1.The Target of the Facilities Granted in the First Seven Months of the Current Year

The value of facilities and their growth percentage in comparison with the previous year have been $50.31 bn and 5%, respectively; albeit, this seems necessary to be adjusted in terms of the inflation rate. Considering CPI equaling 100 in 2011 as the base year, the real values of the facilities granted in the seven months of the last 4 years vs. their nominal values should be presented as below:

Taking the above diagram into account, the best performance in the last four years has been seen in 2014. The nominal value of the granted facilities in 2014 was announced to be $47.88 bn, recording a 44.4% growth compared to that of the same period last year.

Having being adjusted in terms of the inflation rate in 2011, this amount equaled to $23.26 bn, which shows a 26% increase compared to the same period last year. Referring to the CBI, facilities worth of $50.31 bn have been offered via banks in the current year, which demonstrates a 5% rise compared to the same period a year before; but, the real value of the facilities, having been adjusted by the announced 10% inflation rate, has been $22.18 bn, which is 5% lower than the real value of the prior year.

In conclusion, the CBI report on the granted loans by lending enterprises during the first seven months of 2015 implies the credit crunch; a problem which has been stated by Iranian economic practitioners as the origin of the current economic recession, coupled with the non-profitability of many business activities due to the high interest rates.

Banks’ inability in lending side, itself, derives from their assets combination. For instance, over the mentioned period, higher valuations were allocated to the “other assets” item in banks’ balance sheets; an increase which is not resulted from banks’ operating income and it is indeed a non-operating element.

On the contrary, it seems that banks have been forced to acquire such assets due to the non-repayment of the granted facilities defaulted by the government as the biggest organization indebted to the banking sector.

Hence, such external factors have altered banks’ asset combination to the disadvantage of the private loan seekers. Under such circumstances, credit and facilities pricing by decree will not solve the credit crunch problem; the solution rather lies in the CBI and the government accepting limitations over their authority along with maintaining the government’s achievements in fighting the inflation.

That said, at the core of this problem lies a great opportunity, provided that the CBI manages the injection of new funds to banks, adopting the appropriate policies on one hand and attracts foreign financial funds on reasonable payable yields via governmental channels or the private sector through new financial vehicles on the other.

All in all, a brighter economic prospect can be imagined for Iranian firms in the following year as the measures and their proper fulfillment for a more healthy and viable economy and business environment is meticulously monitored and corrected whenever necessary.

*Taken mainly from Tejarat-e Farda Weekly

DISCLAIMER: This report has been prepared and issued by Agah Brokerage Firm on the basis of publicly available information, internally developed data and other sources believed to be reliable. The information contained herein is not guaranteed, does not purport to be comprehensive and is strictly for information purposes only. Agah does not assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions. Any expressions of opinions are subject to change without notice.